For this $60 Billion company, this looks like a transition phase, into the new future of video viewing and content. According to me, it is a business model tweak just at the right time. Let’s look at Netflix business strategy and future readiness
First of all, let us look at the two main cost centers for Netflix:
Create advanced technology infrastructure for improving video streaming experience is very expensive. The truckloads of server space ensuring 99.99% uptime requires high-cost commitment. In February this year, Netflix completed its massive migration on Amazon Cloud. Another very big cost for Netflix is its Data Analytics infrastructure. Netflix has a very good insight into the customers’ content consumption habits on the basis of which it offers customized content and offers.
Content licensing agreements with TV networks, filmmakers, and other content owners is the greatest cost. Netflix spent nearly $200 million to get access to Disney films and TV programming for one year. The full series of ‘Lost’ cost company nearly $45 million, ‘Scrubs’ cost $26 million and ‘Desperate Housewives’ totaled $12 million for a year.
Now, let us look at what are the major business and environmental challenges for Netflix
Netflix’s competitors like Hulu, HBO Go and Amazon have similar business models and cost of doing business. These competitors are not major concerns. Its main competitors are brands like Google and Apple who are cash rich and have a ready base.
Parallelly, the internet and broadband landscape in the United States is changing. The percentage of homes in the US with a high speed broadband connection has definitely fallen. 13% of the users connect to the internet using Smartphones. As per research by USA Today, 33% of the users who shifted to mobile internet said monthly broadband cost was too high and cost of the computer was the biggest barrier. 64% of USA homes have moved to online movie streaming to use desired content. The USA has started to spend around 5.5 hours of the day on online video content. CAGR of 100% between 2011 to 2015 in video content consumption across mobile and tablet devices is mind-boggling. With users having free access to video platforms like YouTube, Daily Motion, Apple iTunes, etc. competition for viewership has increased. In terms of market share of visits, YouTube has largest share of 73.6% followed by Netflix at 9%.
On YouTube, music is the leading category followed by gaming, comedy and film & animation. In the film & animation category, individual content producers are leading. Individual artists and webisodes have the most popular content. Smosh, Nigahiga and the Ellen Show are in top 10 most popular Youtube Channels in the United States.
The number of people subscribing to Netflix in the U.S. is approaching saturation and growth is starting to stagnate. Netflix has started investing a great deal of capital into expanding overseas. The company expanded into Japan recently and has plans to enter other Asian markets, such as South Korea and Hong Kong. The next big challenge for Netflix is to successfully penetrate markets in China and India, two very densely populated markets, highly cost sensitive that could lead to significant subscriber growth.
If the question is Netflix business strategy and future readiness ! Let’s look at some of its key financial numbers which show Netflix’s changing business model:
- Return on Assets i.e. Its ability to generate revenue for every dollar of the asset at its disposal. Netflix’s ROA declined by 9% in 2015. This means that Netflix is spending more cash on acquiring content at a rate that’s greater than the rate of amortization for its streaming content library. However, I am hopeful that these content investments are going to reap better ROA in times to come.
- Netflix has the highest ‘Cash in Hand’ in its category. It’s growth in 2015 reduced by 11%. I am assuming all that money has gone into creating unique content which will repay over the years in existing market or newer markets.
- Intangible Assets (copyrights, digital assets, etc.) of the company has grown by 155% over 2015. CIH declined by 11% and IA increased by 172% could be a sign that Netflix is ready to create new Digital Assets for it’s existing and new markets. Content markets of India and China are highly competitive. Local players have experience and strong hold on content producers. Therefore, new content acquisition in these markets will be crucial for Netflix’s international expansion.
Netflix’s revenue has grown constantly ever since 2013. 28% growth from 2013 to 2014 to $5.50 Billion, and 24% growth from 2014 to 2015 to $6.8 Billion. Revenue growth declined in 2014-15 period which could be owing to investments in new content and technology. Experts project a healthy growth of 22% in revenue in 2016 for Netflix with $8.76 Billion in revenues.
What is Netflix business strategy and future readiness initiatives in 2016 and beyond:
New Content Acquisition
Netflix may spend $5Billion on the content acquisition in 2016, out of which 10% will be spent on original content. Investments into original content will rise to 50% of the total content spends. In 2016, Netflix decided to let go its deal with Epix, which means Netflix will not stream Transformers – Age of Extinction and Hunger Games – Catching Fire.
Netflix is also investing in Real Estate (for now leasing) to build its own studios. Recently, it leased 200,000 square feet of office and pre-production space in Hollywood. Disney Studio has partnered with Netflix to produce original content for Netflix’s consumers in international markets.
Up until roughly two years ago, most of Netflix’s content consisted of movies and TV series to which the company had purchased streaming rights. Today, Netflix’s commitment to original content has resulted in 24 episodic series, dozens of documentaries and comedy specials, and its first full-length feature film, “Beasts of No Nation.” Additionally, Netflix has several dozen more series and movies in development.
Years ago when Netflix had started going the cloud way, it was operating in just one Amazon region without a failover option. And on the Christmas Eve of 2012, it suffered a massive streaming failure. Since then the company has come a long way and continues to strengthen its tech infrastructure.
- Netflix operates it’s own CDN called Open Connect. This helps Netflixes massive amount of bandwidth cost over same content being accessed from the same region across multiple consumer groups. And also helps in better streaming experience.
- Last year Netflix launched the Chaos Monkey project that randomly takes virtual machines offline to make sure Netflix can survive failures without any customer impact. In the later versions, towards redundancy planning, launched two new projects. Chaos Kong and Chaos Gorilla stimulates outage across an entire region of Amazon and shifts workloads to other regions in real-time
- Netflix has a backup of each content on Google Cloud Storage which means in the case of a natural disaster, a self-inflicted failure it will take hours for Netflix to recover, but it will surely be able to fix the issue.
Data Analytics – What customer wants!
- Netflix uses data mining to arrive at a Cost Per Hour viewed estimate for each piece of licensed content. Netflix determines which content viewers pay to see and then compile this data to find the expected hours of viewing of each movie or TV show. This data brings predictability into similar content arrangements on the basis of which final pricing of exclusivity and helps in determining the time frame of the contract.
- Netflix mine for users’ data aggressively. It uses its powerful search algorithms to help its users find the most contextual content and use this facts to decide what type of original content the company should create. This has led to Netflix having a higher success rate in manufacturing hits.
- Showrunners take content decisions rather than business executives. Netflix’s secret sauce is in finding genres and talent that the audience already likes and creates stickiness.
Creating new consumption channels
Netflix has tied up with premier Hotels across the United States and globally with likes of Marriot International to offer high-speed, interruption free content on hotel televisions. Netflix has added a dedicated app to internet enabled television across these hotels. This app allows direct access to Netflix content to hotel guests on large-screen Internet TV, that will transform the in-room entertainment experience. If they are an existing customer, they can continue using their subscription, else sign-up for a new account. Which ensures new customer acquisition for Netflix.
Netflix business strategy and future readiness through advanced technology, and content vision, it is not too difficult to envision Netflix’s sales more than doubling in the next five years, which could easily carry a market capitalization of $70 billion.
One learning that I have from Netflix’s example, change in Business Model at the right time is far more important than temporary loss in revenues and shareholder value. In the end, all depend on, “what is more important, the journey or the destination”.